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CFO Pay Package Survey Exclusive

CFOs see moderate pay gains in 2011 as boards focus on aligning compensation packages more closely with company results.

Slow and steady has its good points, wouldn’t you agree? Just take a look at trends in CFO compensation. Overall pay increased at a respectable pace in 2011 as gains in long-term incentives offset decreases in short-term cash bonuses. While that hardly compares with the surge in compensation CFOs saw in 2010, it’s nothing to sneer at, either. It’s also the look of things to come. The same modest increases likely will be the rule in 2012 as compensation committees set more realistic targets tied to performance. “We’re seeing a return to normalcy,” says Todd Lippincott, leader of the executive compensation consulting business for the Americas at Towers Watson, a New York-based human resources and benefits consulting firm. Recent data back that contention.

A study of the 2011 compensation of 50 Fortune 500 CFOs commissioned by Treasury & Risk and conducted by Equilar, a Redwood Shores, Calif., executive compensation research firm, found median total compensation in 2011 increased 9%, to $5.1 million from the year before. In 2010, Equilar’s survey of a somewhat different group of Fortune 500 CFOs showed a 21.4% rise. In 2011, for example, total compensation for IBM CFO Mark Loughridge grew 7%, to $6.4 million. EMC’s David Goulden’s pay increased 3% to $5.1 million.

These results reflect two counter-balancing trends: smaller cash bonuses and larger stock awards. Median annual bonuses, which include cash payouts of incentive plans, dropped 13%, to $732,292, according to Equilar. The reason: With the economy less rocky and the outlook for corporate performance improved, companies set substantially more aggressive goals than the year before. “Companies felt increasingly secure about the direction of the economy and were able to set more realistic targets, resulting in lower payouts in many instances,” says Aaron Boyd, research manager at Equilar.

At the same time, the value of long-term stock awards increased 37%, to about $2 million. That, Boyd says, reflects the stock market’s gains, which boosted the value of granted awards. In addition, companies stepped up efforts to make a larger portion of compensation rely on equity, rather than cash, increasing the importance of stock market performance to pay outcomes. “As the market recovers, so does the value of the awards being given,” he says.

For instance, IBM’s Loughridge made $1.4 million in cash bonuses, down 8% from the year before, but his long-term stock awards increased 15%, to $4.1 million. EMC’s Goulden’s cash bonus declined 17%, to $1 million while his long-term stock awards rose 9%, to $2.9 million, enough to give him a slight raise.

Individual results vary considerably, however. A study of pay at 64 companies conducted by Compensation Advisory Partners in New York found median overall pay for CFOs rose 7.5%, with short- and long-term compensation comprising about 65% of the total. But “the numbers vary significantly by company, with some paying well above target and others paying well below,” says Melissa Burek, a partner at Compensation Advisory Partners.

Indeed, Equilar’s research shows some CFOs reaped significantly higher rewards last year. David DeVoe of News Corp. saw his compensation rise by a noteworthy 172%, to $17.6 million. That was partly because the company changed from basing equity grants on prior performance to future performance, so his 2011 pay recognized the value of two awards instead of one, according to Boyd. DeVoe also received a grant related to a new employment agreement. At Kohl’s, Wesley McDonald’s total pay went up 105%, reflecting a “career shares” grant fromhis promotion to senior executive vice president at the end of 2010. The grant’s vesting was contingent on the company reaching $1 billion in net income by 2011.

Other CFOs had big drops in pay, especially in cases where company share prices fell. At Alcoa, Charles McLane’s pay declined 41%, to $3.1 million, after a drop in the price of aluminum sent the company’s stock price lower. As a result, Alcoa cut McLane’s bonus by 20%. The reduced stock price also hurt the value of stock awards granted to him.

In 2012, the pattern of slow increases is likely to continue, depending, of course, on a number of factors. One key is the stock market, since so much of total pay is determined by long-term compensation. Still, “I would expect that unless there’s a significant macroeconomic shock, the following proxy season will fall out in a way that’s similar to the current one,” Lippincott says. Most important, he says, is that compensation committees feel more comfortable setting targets than they have in recent years and as a result, there’s less likelihood of seeing a disconnect between payouts and targets.

“I expect to see a good year, not a great year,” says Mike Halloran, worldwide partner at Mercer, a New York-based human resources consulting firm.

Overall compensation should be up 7% to 10% in 2012, predicts Steven Van Putten, managing director of Pearl Meyer & Partners, a New York-based compensation consulting firm. However, Van Putten expects gains to vary by industry. Sectors like manufacturing that are more linked to overall economic improvement will see pay increases at the higher end. There also should be more variation from company to company in volatile industries such as life sciences and technology.

Salaries, which have largely been flat recently, should see more of an uptick, partly as a retention move. “Boards feel they have the right executives and they want to focus on keeping them,” says Randy Ramirez, director in the compensation and benefits practice at BDO USA, a Chicago-based tax and financial services consulting firm.

Companies will likely continue to set more aggressive goals for short-term compensation. “It’s going to be about growth, not maintaining the status quo,” Ramirez says. Annual incentives should be from 100% to 200% of base salary, says Joshua Wimberley, head of the North American financial officers practice at Korn/Ferry International, an executive search firm in New York.

But perhaps the most salient feature of compensation going forward will be the continuing increased reliance on results. “Decisions will be grounded in performance,” says Compensation Advisory Partners’ Burek. Long-term pay should comprise a larger part of the total, with about half of those incentives based on performance, she says, and about a third in stock options.

The movement toward ever-more pay for performance should also mean stepped-up use of restricted stock. A small portion of that will be based on tenure, a practice known as pay for pulse, since such payment does not reward executives’ contributions to results. A larger part will be performance-based, with upside and downside potential, allowing executives to earn more or less than the target depending on their performance. Some companies have been using market stock units, or MSUs, allowing CFOs to earn a greater number of shares if the stock price increases, according to Van Putten.

Such performance-based restricted stock also can serve to keep CFOs from jumping ship. Turnover among CFOs is now at about 12%, according to Korn/Ferry, but it’s much higher in certain industries, such as consumer goods.

Still, measures aimed at retaining executives are like tilting at windmills. “Companies step up and buy these retention deals out,” Wimberly says. Only in rare cases will companies shy away from doing what it takes to recruit a much sought-after CFO.

The metrics used for compensation are likely to be all about growth. While measurements a few years ago emphasized cash flow, going forward, they’ll focus on expansion opportunities. That should mean metrics such as revenue and profit growth, as well as total shareholder return, especially as measured against another yardstick, according to Van Putten. For example, companies might link the vesting of a stock plan to total shareholder return achieved compared to that of a peer group. “They’re trying to ensure there’s a relationship between pay and the return investors receive,” Lippincott says.

Metrics may vary according to industry, Halloran says. Capital-intensive sectors, for example, may focus on return on investment to hold executives accountable for getting an adequate bang for the buck. Or companies could use metrics emphasizing their strategic focus or even creating a more diverse workforce.

Compensation committees also may make more use of discretionary pay, according to Van Putten. “They’ll take into account aggravating circumstances,” he says. Still, there’s some disagreement about the issue. Burek says there’s likely to be less reliance on one-off bonuses at the end of the year. In any case, the process will involve a rigorous analysis, comparing the company’s performance against a group of peers, to ensure the move can be justified. “They may use some discretionary judgment based on performance, but it won’t be awarded because you tried really hard,” she says.

In fact, boards continue to ratchet up their scrutiny of compensation. “They’re looking more closely and rigorously at the analytics and thought behind how these deals are structured,” Wimberly says.

In large part, that’s to avoid the glare of public attention if they get it wrong, Van Putten says. Boards are more involved in evaluating performance goals and making sure metrics are aligned with shareholder value. And they’re using increasingly more rigorous goal-setting methods, not just comparing targets to those used by other companies in their industry, but often considering the impact specific situations would have on pay. “They’re doing stress tests,” says Van Putten. “They’re looking at, for instance, if performance were to go south, what impact that would have on bonus plans.”

In fact, concerns about setting inappropriate targets are causing some boards to reject management’s plans and demand they go back to the drawing board, according to Steven Hall, managing director of Steven Hall & Partners, a New York-based compensation consulting firm. Hall says he’s seen perhaps six cases so far where that’s happened. “They’re saying, ‘You have to come up with something better, because we can’t set targets with that level of performance,’” he says. “‘Figure out how to earn more.’”

The bottom line: ensuring that good performance will get rewarded—and disappointing results won’t. “Where the team exceeds expectations, they’re going to receive significant payouts,” Wimberley says. “When they miss, the board is going to restrict their payouts.” He points to one Fortune 100 company where, thanks to disappointing performance, payouts were “closer to 20%” than the previous year’s 80%. Such reductions will be typical in 2012, as well. “Boards are really holding executives accountable for driving shareholder value,” Wimberly says.

Part of that effort involves continuing to eliminate such perks as tax gross-ups and overly generous severance packages. “If you go back a year or so, board action was around low-hanging fruit,” Van Putten says. “Those have been tossed out.”

Perhaps the most critical factor impacting boards is say on pay. Dodd-Frank mandates that shareholders vote at least every three years on executive compensation So far, there have been few instances of investors nixing pay packages. The vote is nonbinding, but getting more than 30% of no votes is regarded as a bad sign. And the news coverage when Citi got about 55% of no votes for its executive pay demonstrates how embarrassing such an outcome can be.

“Before, there wasn’t much incentive to avoid it, but now there’s a significant risk to reputation if there’s a negative vote, not to mention the possibility of lawsuits,” says Subodh Mishra, vice president at proxy services firm ISS in Rockville, Md. Ramirez agrees, saying, “What was viewed as non-binding and toothless has turned out to be a significant influence on compensation planning for boards.”

Ramirez, in fact, has seen many instances where the board has focused on how shareholder groups will view a compensation plan. That’s a very different emphasis from just a few years ago, he says. “They want to know if it will pass the ISS test or if there could be a problem.”

And in cases where a significant portion of shareholders express their disapproval, companies have responded by revising their packages—quickly. Take Beazer Homes USA. Last year, only 46% of shareholders approved the company’s pay package. After Beazer instituted such changes as stronger stock ownership requirements and a double trigger for change-in-control agreements, the vote this year was 97% in favor.

When it comes to other changes required by Dodd-Frank, companies are generally taking a wait-and-see-attitude until they get more clarification from the Securities and Exchange Commission. Take clawbacks. Dodd-Frank requires that companies put in place procedures for recovering compensation from executives if there’s a restatement, going back three years. But the law contains few specifics, so the SEC is supposed to produce more detailed requirements. Many companies are waiting for the official rules before putting in place policies. Of those that have instituted procedures, says Hall, “From what we’ve been able to determine, almost none of these plans would comply with Dodd-Frank. They’re not aggressive enough.”

Of course, some of these steps also may have unintended consequences. For one thing, there’s the effect of performance-based measures on what Wimberly calls “healthy risk-taking.” When more weight is given to long-term compensation, “that can be a real challenge,” he says. There’s also the matter of new approaches to restricted stock. In some cases, companies are putting in place plans with vesting in three to four years, but including a requirement that the company reach such short-term hurdles as specific revenue targets, according to Ramirez. Such contingencies could encourage executives to “bank on the sure thing, so they hit that target,” he says.

Another question involves stock awards granted during the recession, when the market was down. Those awards have started to vest and because the market is on an upswing, “you’re going to see people start to cash them in,” Boyd says.

No matter what, however, one prognosis seems likely: modest increases will be the norm in 2012.

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